Contributing editor Shawn Allen is with us this week with a look at some successful retail stocks and why they are so rewarding for investors and the company owners. Shawn has been providing stock picks on his website at www.investorsfriend.com since the beginning of the year 2000 and has a great success record. He is based in Edmonton. Here is his report.
Shawn Allen writes:
Retailing usually provides relatively low profits as a percentage of sales. But that does not mean that the return on equity is necessarily low. For example, if sales are seven times higher than the equity investment then a low 2% net profit on sales translates to very satisfactory 14% return on equity.
Here are the figures for the retailers that I follow.
| Profit/ Sales | ROE | |
| Canadian Tire (TSC:CTC, Financial) | 5.2% | 13.4% |
| Alimentation Couche-Tard (TSX:ATD.B, Financial) | 3.6% | 25.9% |
| Walmart (WMT, Financial) | 3.0% | 19.0% |
| Costco (COST, Financial) | 2.0% | 21.2% |
| Dollarama (TSX:DOL) | 14.5% | 63.8% |
| Amazon.com Inc. (AMZN) | 1.6% | 13.6% |
| AutoCanada Inc. (ACQ) | 1.5% | 10.4% |
For these companies, the returns on the book value of equity range from good to exceptional. But certainly not all retailers are profitable.
The role of the retail sector in the economy is to bring goods to locations that are convenient to consumers. The most successful retailers benefit society and consumers by being highly efficient at this. A highly efficient retailer can earn good profits while still offering attractive prices.
In its purest form, a retail operation sells the same products as its competitors. Grocery stores, liquor stores, and gasoline stations to a good extent face this situation. In this environment it may be that only the most efficient and lowest cost operations can make attractive profits.
In order to avoid competing strictly on price, retailers often attempt to differentiate their products. This can be accomplished through branding and advertising and through contracting with manufacturers to provide products under the store's own brand name. Examples include President's Choice at Loblaw's, Kirkland at Costco, and Noma at Canadian Tire. Some retailers only sell products that they or a parent organization manufacture.
Retailers with multiple locations have an advantage over retailers with only one or a few outlets. Scale provides advantages in terms of the efficiency of advertising and in purchasing power and administration. Larger retailers can source directly from manufacturers rather than purchasing from wholesalers. For that reason, the retail industry is dominated by large chains with hundreds or thousands of stores. Due to efficiency gains, the demise of the "Mom & Pop" retailer was inevitable.
The retail road to riches
Retailing can be very lucrative, which is proven by the fact that retailers are well represented in the top ranks of the world's billionaires. This includes Amancio Ortega, the founder of Zara's who is number two on the list, Jeff Bezos (Amazon), who is number five, and three of Sam Walton's heirs (Walmart), who are numbers 15, 16, and 17. Together, Walton's heirs top the Forbes list of America's wealthiest families.
In Canada, the list of retail billionaires includes the Sobey's family, three of the founders/executives of Couche-Tard, the Weston family, and Daryl Katz of Rexall. In cases where these retailers took their enterprises public years ago, early shareholders who held on to their stock have also become very wealthy simply by being astute enough to ride the coattails of these highly successful retailers.
For retailers, success is often judged by the ability to increase same-store sales. This is certainly important when the price of the stock is already reflecting and "pricing in" a certain level of growth. However, there are limits to how much traffic and product can be pushed through each location. For some retailers, increasing the number of locations is of equal or greater importance in driving growth. If there is no inflation in prices, then it may be unrealistic to expect a retailer to achieve increases in same-store sales.
E-commerce strategies
Most large retailers have been impacted by online competition and have had to adopt e-commerce strategies. Amazon is the clear leader here and is a particularly tough competitor in that it has given sales growth a much higher priority than profitability.
Canadian Tire has adopted the rather audacious vision of becoming "the most innovative retailer in the world in the eyes of [its] customers". The company is investing aggressively in this area as it transitions "to the new world of omni-retail". To date, Canadian Tire's sales do not appear to have been affected by online competition to any material extent.
Alimentation Couche-Tard's convenience goods and gasoline are not likely to be affected by online competition and I am not aware of any e-commerce strategy at this company.
Walmart is pursuing e-commerce aggressively. It has focused on fulfillment centres where customers can pick up goods ordered online. It is also acquiring JET.com for $3 billion to augment its e-commerce efforts.
Costco has had an online division for some years. It has been criticized for not being more aggressive in this area. However, Costco's strength is in its low-cost warehouse operations and it may be wise not to attempt to compete too directly with Amazon.
Dollarama's products for the most part are not particularly susceptible to or conducive to online ordering and delivery. Nevertheless, it recently announced that it may implement an online division to serve bulk orders of its products.
AutoCanada displays its vehicles online. This company is somewhat protected from e-commerce in that the car manufacturers are obligated and incented to protect their dealer network. In the U.S., many states actually have laws prohibiting manufacturers from selling cars directly to consumers. Canada does not have such laws but there is no indication that the manufacturers are about to abandon their dealers in favor of e-commerce.
Investor considerations
Retail companies have the advantage of being simple and easy to understand. Investors can choose to shop at retailers where they own shares. This gives them added insight into the nature of the companies. Logically, the purchases that an individual investor makes are not going to add anything beyond an infinitely small amount to a company's per share returns but shopping at a retailer where you own shares can provide a good degree of satisfaction.
I follow several retail companies for the IWB and all are performing well. Last month, I advised selling one of my retail picks, Costco Wholesale, at US$167.70 for a profit of 44%. That turned out to be a timely call as the shares have since pulled back.
